Deutsche Borse-NYX Tie Up, $400M in Synergies. Where They Going to Come From?

As Ricky Ricardo said to Lucy, “Someone has some splainin’ to do.”  How is the DB-NYX merger going to save $400M in expenses?  I can speculate where they might find some savings.  But, the proof will be in the pudding.

Looking at past exchange mergers there have only been a couple where the projected savings actually panned out.  One was $ICE and NYBOT.  ICE closed the NYBOT floor, and via the acquisition inherited a clearinghouse. Additionally, there was growth as NYBOT products were forced onto a screen.  The human traders were out of business and the HFT guys took over. When $CME bought CBOT, there were all kinds of synergies.  In fact, the projected synergies were conservative.  They found more money in the melding of the two organizations than they thought previous.  When $CME bought NYMEX, it was a dead merger.  Some staff were cut, but the synergies were not there since NYMEX already was using $CME technology.  $CME didn’t close the NYMEX floor.

In the DB-NYX merger, there is a merger of three separate parts of the business.  Looking at them one by one, there are no synergistic cost savings in the stock part.  NYX isn’t about to close its floor.   NYX has had a terrifically difficult time merging its option technology, I can’t imagine that for the short run they will continue to keep running two sets of technology platforms on their stock business. They will also have to merge the former French stock exchange, Euronext into the DeutscheBorse.  This could be tricky.  The options business also will have to be migrated to one platform.  They will be trying to meld five options exchanges into one. There will be tremendous operational hurdles there, not to mention regulatory ones.  Then there is the derivatives piece. Entirely European in nature, two separate systems.  Eurex uses a different matching algorithm than LIFFE.

The real cost behind all these exchanges is not any different than your regular business.  Cutting costs isn’t rocket science, it’s about getting rid of headcount.  The current French and German labor laws make it difficult to get rid of headcount.  DB/Eurex has famously done a lot with a little when it comes to employees.  They have one of the lower head counts per output in the exchange world.  Employees at all the merged exchanges have to wondering who is going to get the axe.  It’s the only way to save a lot of money.

Customers will reap the biggest savings.  Cross margining the entire yield curve of European interest rate futures will yield similar dividends that the CME/CBOT cross margining agreement yielded.   Not only that, but customers will get to save money on their stock index futures and metals futures through netting of positions. But the bankers better not be figuring those savings into the actual merger.  I expect those savings to be in the hundreds of millions, maybe even a billion or more US dollars.

There are still some significant hurdles to go for the merger to happen. One is regulatory approval on both sides of the pond.  If you saw what EU regulators did to Microsoft, I would imagine that they will take a pretty keen eye to this merger too! The Department of Justice, via prodding by lobbyists, took an eternity to examine the $CME/CBOT merger, and the $CME/NYMEX merger. Will they use the same “care” when it comes to this one?

The other side of this merger is growth.  There should be some tremendous opportunity to grow the options business, and the listed futures business simply with the contracts they already have in hand.  The capital efficiencies from lower margin frees up more risk capital to trade.

What could sap that growth?  Turning a competitive cannon to another exchange.  It is enormously difficult to pry an established contract away from an exchange, and it is enormously expensive when competing head to head.  The only time contracts have left exchanges is when they have been sold, or when an open outcry arena was competing against an electronic arena.  It has never happened open outcry v open outcry, or electronic v electronic.

NYX is counting on its cash treasury trading operation to be the wedge that pries the treasury futures from $CME Group. In the past, when exchanges have looked at this they couldn’t get around the intense haircut traders take when trading and margining cash treasuries. Have they figured out a better mousetrap?  If so, it could get interesting.  If not, it is probably already a fait accompli.

The other facet of exchange mergers that I have seen is that investment bankers tend to overstate valuations and cash flows.  In the $CME/NYMEX deal, the beta they implied, and the interest rate they used to discount the cash flows proved incorrect. $CME paid $7.7 billion for something that was probably worth quite a bit less than that.  There is a high likelihood that they will screw up valuations and cash flows again. In their defense, it’s an art not a science. But it makes a huge difference on what shareholders think.  Merger participants sometimes engage in as much spin as any political campaign.  What makes anyone think the boards, and bankers for $NYX and DB aren’t doing that right now?  Certainly $CME did for both the CBOT and NYMEX buyouts.  $ICE did their share of campaigning when they tried to disrupt the $CME bid for CBOT. Duncan and Rudi are on the street kissing babies.

I find it interesting to see $NDAQ squirm.  Because the media is so New York centric, they are under the impression that $NDAQ is a big fish.  In reality, they are a guppy.  They run a declining business due to government regulation.  Their supposed synergies with OMX haven’t been as big as they thought, and market growth synergy hasn’t been as big either.  In the exchange merger game, they are a wallflower at the dance.  $ICE and $CBOE are better looking.  If regulators allow the $NYX-DB deal to go through, why wouldn’t they let a merger of $CME, $ICE and $CBOE happen?  $CME has the firepower to buy both.  Plus they run profitable businesses. $NDAQ doesn’t.

On CNBC today, $CME exchange executive chair Terry Duffy said they are going to concentrate on their business.  My guess is they will.  As UCLA basketball coach John Wooden famously said, “Be quick but don’t hurry.”  It’s good advice right now.  I still think a hostile bid might be an interesting way to force DB to use more cash.  But, any hostile bid would probably be unsuccessful.  There are more apparent synergies between $CME and $NYX, simply because of the ability to shut down one trading floor in New York City.  It’s not clear what they will be across an ocean.

(for the record, as I have stated previously on blogs analyzing exchanges, I do hold $CME shares.  I am not, nor have ever been an employee of $CME)

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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